Correlation Reprise

An earlier post mentioned that correlation is not causation. In other words, just because two things seem to change more or less in sync with each other, that does not mean that changes in one caused the changes in the other. The article linked below compares annual change in U.S. Gross Domestic Product with annual change in the S&P 500 stock market index. Our question: do these two measurements have any obvious degree of correlation?

At first glance it is hard to see much of any correlation between growth in the GDP with growth of the S&P 500 index. Certainly there is no easy way to identify an equation that would relate the two using linear regression. This irritates our intuition, which tells us that a growing stock market must reflect a growing economy. On the other hand, the fact that so many (not all, but many) of the years fall into the upper right quadrant of the chart does satisfy our intuition at least a little because it tell us that for many of the years, if the economy grew the market grew as well.

The chart as a whole seems disappointingly random, almost like a scattergun shot the data onto the plot. And even though we cannot pin down any predictive or quantitative correlation, this lack of correlation suggests that the two factors may not be related in the ways we expect. The article explains that the GDP is a measure of something that has already happened while the behavior of the stock market is often more of a forward-looking measure. Related, but not as directly as our intuition might tell us. Interesting to consider.

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